Underwriting standards are basically rules that help ensure loans that are given are protected. They determine how much money can be given to a borrower, the terms that will govern this line of credit, the amount given and the interest charged.
Underwriters in most cases are employees of the lending institution that extends a line of credit. The process of underwriting in real estate verifies the borrower and the property. Having provided certain documents to the lender the underwriter is then required to go through the documents again verifying the details given. Underwriting ensures that there is further investigation into the borrower and their ability to pay. They must check their credit score and payment history. This will help ascertain if the borrower has shown proof of their ability to pay off debt successfully in the past. In addition, the lender must also investigate the property to check for its viability as collateral and if it is a low risk investment. The property will go through several checks to verify the details given. The property must be appraised by a value, surveyed, and insured.
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The importance of this process is that underwriting can and often does have an effect on mortgage rates and prices of property. In the lead up to the financial crisis less stringent underwriting regulations ensured that there were lower rates for down payments. These lower rates meant that borrowers had access to high value homes. The buyer with a $10,000 down payment had access to homes in the $100,000 to $200,000 range. Unfortunately, the result of these higher loans often ended up being mortgages that could not be paid off. The Housing Crisis resulted in many foreclosures and evictions. Several factors influenced the real estate boom that occurred and led to the collapse that devastated millions of homeowners ( Furfine, 2018).
The changes that had the highest impact include the lowering of underwriting standards. The first is discussed above. The lowering of rates of down payments or their complete nonexistence. Between 2005 and 2006 14% -17% of mortgages were financed without a deposit. He also discusses the interest only mortgage gave a buyer a smaller monthly repayment than the previous amortized mortgage. The other form of mortgage was the option ARM. This gave a starter interest rate that was incredibly low and equally attractive monthly payments that could not be found with other types of mortgages available then.
Underwriting before the bubble never allowed buyers with a high mortgage to income ratio to take home loans. Jurow (2010) explains that by the end of 2005, the ratio of average debt to income was as high as 50%. This gave many buyers who would only dream of purchasing a home the opportunity to do so. Policy changes of his kind resulted continuously in bad practices that encouraged the real estate collapse.
After the real estate market collapsed, several changes were made to the mortgage underwriting standards. Many of these changes were made to protect players in the real estate industry. The first measure was the closer scrutiny that was applied to clauses in loans. This is because mist financial institutions were not favored when loan work out processes were presented in a judicial process. The borrowers were often favored because the courts were made to understand that the borrowers were misled. Real estate companies and realtors were charged with promissory fraud because they offered the borrowers terms that were not explicitly explained. The meaning and intent behind contracts with loan modification are now more carefully considered under a court of law. The second measure put in place was by the federal government. The regulations are now revised to allow for better negotiations in the case of loss.
They make qualification for mortgages more strict and fool proof. Another change has been in the length of the foreclosure process. Yeager (2015) states that this has been made so to avoid the accidental loss of property and to prevent a future breakdown of the real estate market. The number of valid legal representation has reduced. This is after the initial breakdown led to a narrowing of lawyers and brokers that were allowed to contract business. The final significant change is the oversight of judiciary in the non judicial process of foreclosure. This is to protect both borrowers and learners.
The following is an example of current underwriting standards. Most mortgage lending institutions provide consistent and fixed formal credit policies that outline the bank's limits in taking risks. Measurements standards are offered for the borrower and the bank or kindergarten measures them according to their approvals. Financial analysis is done based on standardized loan approval documents that have passed collateral violation and covenant provisions. Performance to access projections is also done based in forward looking tools. They clearly outline the key determinants of performance by comparing various scenarios and the company’s projections. Each loan or mortgage that is issued is broken down into stages. The first is a qualitative evaluation that determines the loans credit risk before and during issuance. The second is a system to access the quantitative risk that may take place during the life of the loan.
This includes repayments and interest calculations and timely remittance. The last commonly used standard is the access if information systems that assist lenders to simplify the lending process. This includes getting an up to date report detailing the borrower’s risk and performance portfolio. The lenders try to simplify this process so as to guarantee they get the highest number of customers possible. Most of these credit standards shape the industry and are determined by the past failures and successes.
References
Furfine, C. (2018). The Impact of Risk Retention Regulation on the Underwriting of Securitized Mortgages.
Jurrow K., (2010)" Terms of Endearment: How the Speculative Madness Was Financed" Retrieved from http://www. worldpropertyjournal.com/us- markets/residential-real- estate-1/real-estate-news- Keith-jurow-real-estate- finance-real-estate-bubble- home-loans-mortgage-loans-reo- properties-housing-bubble-new- york-times-2335.php
Yeager, C. F. (2015). Impact of Underwriting on Residential Foreclosures in Chicago Communities. In The Sustainable Global Marketplace (pp. 497-501). Springer, Cham.
